Why I still need some convincing over the prospects for Bitcoin

Only time will tell if the cryptocurrency will become digital gold, used by shrewd investors as a hedge against inflation

Bitcoin has become ever-more mainstream in recent years (Reuters)

If Independent readers’ inboxes are anything like mine, they will be full of advertisements – of varying degrees of legitimacy – about how to make a fortune buying Bitcoin.

Some of the emails I get, purporting to be from all kinds of famous people, are clearly rip-offs. And claims within other emails that the Chinese government is involved with or underwriting Bitcoin are particularly dodgy. But since Elon Musk has bought $1.5bn (£1.2bn) worth of Bitcoin, the concept itself is not. Musk seems to be quite a character, but you don’t get to be the richest man in the world by luck, let alone by falling for internet scams.

So I asked myself: "what is going on here?" Someone is paying my service provider for the relentless stream of adverts. The company which is marketing Bitcoin will be earning a healthy fee. There is a stream of income somewhere funding these costs. So what is the product that this profitable industry is trying to get me to invest in?

The way it was explained to me is that it is like the 19th-century gold rush. A new precious metal has been discovered in the form of an artificial unit of account, the bitcoin; one of a series of cryptocurrencies. The artificial currency cannot however simply be created except by the "miners" with supply being controlled by the means of production from digitally secure "mines" (secured by blockchain technology, which marks every transaction). In fact there is a fixed supply of 21 million bitcoins.

Just as there are other precious metals –silver and platinum – there are other digital currencies. But Bitcoin is the gold of the digital world. And its value lies in its scarcity; the more people demand it, the more valuable it becomes.

A lot of the confusion around Bitcoin arises from the fact that as of now it has some but not all of the characteristics of money. Money has two main purposes. The first is to help us make transactions. The second is as a store of value.

Traditionally, transactions have best been carried out by coins and notes. But that is a rather old fashioned way of looking at money. These days, small transactions are carried out by "contactless", instantaneous payments from our bank accounts, using debit cards. We then move up to bigger debit and credit card payments using PIN and beyond that to cheques, drafts and other secure bank transfers. In a modern economy, money mostly consists of exchanges between current accounts.

There are other forms of money which are less convenient for transactions or less trusted. We wouldn’t normally take gold bars to the shop (or for that matter bags of coins): inconvenient. Nor would we take a piece of paper with IOU written on by someone we know: untrusted. Nor would shops usually accept dollars or euros, if only because of the hassle and cost of conversion. If we lived in Bristol we could perhaps use a "Bristol pound" but only amongst the few hundred people and few shops who have agreed to use it.

What about paying in Bitcoin? At present, not directly, though PayPal is currently in the process of enabling people to do so. Meanwhile, Tesla accepts the currency and Mastercard is toying with the idea of using it or other cryptocurrencies. Nonetheless, it is quite tricky to settle an account in Bitcoin, not least because the value in terms of conventional currencies changes rapidly.

China, whose retail system is bigger and more advanced than ours, is thinking of getting rid of old-fashioned ideas like cash and cheques altogether. Transactions will be entirely electronic and conducted in what could be a cryptocurrency at the rate of so many units per yuan.

The promoters of Bitcoin in my email are making much of this, implying that their own currency will have a value guaranteed by the Bank of China. That is a big, and fallacious, jump in logic. I suspect that the Chinese have no plans to underwrite the value of other cryptocurrencies.

The main appeal of Bitcoin has nothing to do with transactions and everything to do with being a store of value. The alternatives are limited. Bank accounts are secure but usually earn a miserable return after inflation. Gold is cumbersome, needs safe storage and doesn’t pay interest or dividend.

Shares need some understanding of their companies. Artwork requires specialist knowledge. Property has to be maintained and is not easily bought and sold in a hurry without big expenses. Land value depends on the fickle assessments of council planners.

As an alternative store of value, Bitcoin is uncomplicated and seemingly secure, though of no intrinsic usefulness and generating no regular income. Its great appeal is that it seems to rise inexorably in value – except for a nasty dip of 80 per cent from a peak in 2017.

The more Bitcoin is bought the higher the price (since there is only a fixed amount to go around). People start to ask “why am I missing out?". And as even more pile into the market the higher the price goes. Those who got in early can tell their friends that they made a fortune – they did. Some may even make money on the side advertising their success.

Sadly, this is a familiar story. There is a museum in Amsterdam which tells the story of how, in 1637, the normally staid and cautious Dutch were caught up in a frenzy of enthusiasm for buying tulip bulbs. They bought and bought and the price rose and rose. Weight for weight, tulips became considerably more valuable than gold.

Until some investors started to worry that the tulip was over-valued and started selling, pushing down the price and creating panic. The market crashed causing ruin to many of those who treated tulips as a store of value for their savings rather than an attractive flower.

So, while Bitcoin as a concept is not as hazardous as some of the email scammers who promote it, I am suspicious of it as a long-term investment. It is not as risky as giving my bank details to those who contact me from Novosibirsk and Mumbai, telling me that if I do not respond I may lose a DPD parcel, fail to get Amazon Prime renewed, or face arrest by HMRC. But it is not a guaranteed money-making machine either.

Only time will tell if Bitcoin will become digital gold, used by shrewd investors as a hedge against inflation, or a digital tulip, which could by turns enrich and then impoverish. Either way, I will sit this one out.